Russia stocks suffer worst week since May 2012

Investors debate whether it’s time to buy; Crimea vote could prompt more turmoil

An earlier version of this story incorrectly named the country that owes Gazprom $1.89 billion. It is Ukraine.

MADRID (MarketWatch) — A week of frenzied geopolitical tension over Ukraine took a toll on Russia stocks, which logged their worst weekly losses in just under two years.

The blue-chip MICEX index
XX:MICEXINDEXCF
finished with barely a pulse, up 0.1% to 1,339.36 on Friday, but it lost more than 7% on the week. The last time the MICEX fell that hard was the week ending May 18, 2012, when it tumbled 8.66%, according to FactSet.

The week started with dramatic losses for Russia over an escalation of the Ukraine crisis, with a drop of 11% on Monday. MICEX stocks were still being tossed around by the diplomatic back and forth as the week continued. On Thursday, shares lost another 1% after the local government of Ukraine’s breakaway territory of Crimea said it will hold a March 16 referendum to decide whether it becomes part of the Russian Federation. Also see: White House announces sanctions tied to Ukraine. That referendum could turn into another watershed moment for markets.

A phone call between Russian President Vladimir Putin and President Barack Obama didn’t seem to have much impact. Obama urged a diplomatic solution and Putin again repeated his call that Ukraine’s government isn’t legitimate, and he “can’t ignore calls for help” from Crimea and eastern and southeastern regions of Ukraine. The State Department’s top 10 Russian lies about Ukraine

Shares of Gazprom OAO
RU:GAZP
rose 0.3% in Moscow, but sank nearly 11% for the week. The company on Friday warned Ukraine to pay its bill or risk losing its gas supply, AFP reported Friday. The company is owed $1.89 billion by Ukraine, and Gazprom Chief Executive Alexei Miller said the country risks returning to a situation similar to the start of 2009. The cutoff at the time also cut supplies to much of Europe. Read: Why Ukraine and Russia matter to commodity markets

As for U.S. investor exposure, the pain was there for all to see as the week wound down. Among exchange-traded funds, the iShares MSCI Russia ETF
ERUS, -0.51%
and the SPDR S&P Russia ETF
RBL, +0.00%
each fell more than 6% for the week, contrasting with a 0.1% gain for the iShares MSCI Emerging Markets ETF
EEM, -0.27%

As for the investment calls on Russia, it’s not exactly clear cut. Late Thursday, J.P. Morgan Cazenove’s Hong Kong-based strategist Adrian Mowat said investors should unwind Russian stock holdings. He predicted emerging-market money managers will cut their positions because Russian holdings are more than double the long-term average, Bloomberg reported.

Mowat sees nothing good coming from the central bank’s rate hike earlier in the week, saying it will hit the economy and stocks, while a weaker ruble and higher inflation and lower confidence among Russian businesses will cut into domestic demand and investment

‘Ridiculously cheap’ Russia and what the word ‘nuclear’ did back in 2012

As for those who say buy, Peter Garnry, head of equity strategy at Saxo Bank, said earlier in the week that volatility over Russian stocks will remain elevated for some time, but that will “breed opportunities.” Also: Russia is corrupt, but its markets are bargains

In a note, Garnry said that the MSCI Russia Capped Index (ETF
ERUS, -0.51%
) had underperformed world equities by more than 20% in 2014 alone. Like many others, he predicts an eventual diplomatic solution for the Ukraine crisis as neither Russia nor the West want a war. Plus, the Russian economic outlook is positive, he said.

And here’s the part where he thinks Russian stocks are “ridiculously cheap.” The MSCI Russia Index, he says, is trading at 12-month forward price-to-book ratio of 0.54, which means return on equity that is 50% below cost of equity. And a 12-month forward price-to-earnings ratio of 3.6% is a quarter of the developed world’s average. This doesn’t make sense he says, unless “the world is coming to an end.”

More statistics from Garnry show the 12-month expected return on equity is currently 17.1%, and even adding in risk factors, the MSCI Russia Index still should trade closer to 1 at a 12-month forward price-to-book ratio, implying an 85% upside.

Knee-jerk reactions to political events are nothing new for Russian stocks.

The New York Times reports that on May 18, 2012, Russian markets lost 3.5% within four hours due to a single mention of nuclear weapons from Prime Minister Dmitry Medvedev, who was talking about the unintended outcomes of military campaigns.

“The recent, hasty military operations from inside foreign states usually end with the arrival of radicals in power,” Medvedev reportedly said at the time. “At some moment, such actions, which undermine sovereignty, can end with a full-fledged regional war, or even, and I don’t want to scare anybody, the use of nuclear weapons.”

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